3 Partnerships Worth a Second Look

Master limited partnerships, or MLPs, are a great way to boost your portfolio's income. However, the MLP space can be a minefield for inexperienced investors. While some MLPs may appear to offer high annualized dividend payouts or distributions, in many cases these distributions are variable and can change with little or no notice. 

Why can MLPs have such high dividend yields?
With more reward comes more risk, and MLPs are no exception. MLPs are able to achieve such strong dividend yields because their income is not subject to corporate income taxes. Instead, owners of an MLP are personally responsible for paying taxes on their individual portions of the MLP's income, gains, losses, and deductions. This eliminates the double taxation generally applied to corporations. All in all, this means more cash is available for distributions.

However, every unitholder is responsible for the taxes on his or her proportionate share of income, even if the MLP does not pay a cash distribution. In addition, although unitholders are usually limited in their liability, creditors of MLPs have the right to seek the return of distributions made to unitholders if the liability in question arose before the distribution was paid. This liability stays attached to the unitholder even after he or she sells the units.

Because of this, MLPs can be difficult instruments to own despite their promise of higher income. Moreover, it is important to note that cash distributions are not guaranteed, and prospective investors need to evaluate whether or not the MLP can sustain its payout/distribution.

Taking all of this into account, I have arrived at a short list of three MLPs that look well-placed to continue their payout and reward investors far into the future. 

The contenders
Let me be clear: I don't think that these MLPs are risk-free. In my opinion, though, they have bright prospects and their payouts look secure. We all have our own opinions (that's what makes us Motley), but it always helps to have another view on the matter. 

High risk, high yield
Northern Tier Energy
(NYSE: NTI  ) is my high-risk play here. The partnership owns one refinery and a retail division called Super America.

Source: Super America.

However, most of the company's revenue comes from its one refinery. Of course, having only one refinery is a significant risk for the company, but with significant risk comes the potential for significant reward. Northern Tier has rewarded its partners well in the past. Since October of last year, Northern Tier has returned $4.66 per unit to investors -- a yield of 20% at current unit prices. This is an average distribution of $1.16 per quarter for the last for quarters.

That said, Northern Tier's last two distributions have been significantly lower than average due to unplanned and planned maintenance as well as a declining Brent-WTI price differential. Even with the distribution cut to $0.31, though, the partnership still has an annualized yield of 5.5% -- impressive.

What's more, with the WTI/Brent differential currently widening again and planned spring turnaround activities out of the way, Northern Tier should be set to produce some record results during the next quarter.

Northern Tier paid out $230 million in distributions during the first six months of this year; unfortunately, this was hardly covered by the company's $56 million in free cash flow during the period. This means the company had to dig into its cash reserves to fund the distributions. Northern Tier is high risk, but the risk could be worth the reward.

Short-termism
Terra Nitrogen
(NYSE: TNH  ) has been hit hard recently as investors sold off the company due to a bad quarter. However, Terra's bad performance was once again due to planned turnaround activities which should boost near-term performance. As Terra is a partnership, though, lower income means a lower distribution. Still, the lower distribution of $2 per unit is still 4% annualized.

Source: Terra Nitrogen.

Terra's main product is nitrogen fertilizer, a highly defensive product that is likely to see strong demand over the long term. Having said that, the company only has one production facility and is highly exposed to natural gas prices, a key ingredient of nitrogen fertilizer.

The price of natural gas should remain depressed due to the hydrocarbon boom currently under way in the United States. Excluding the bad third quarter and subsequent poor fourth-quarter distribution, Terra's average distribution for the last three quarters was $4.11; this gives it an annualized yield of 8.3%. These distributions have been covered by operating cash flow for the first nine months of this year.

Pipelines
A great way for investors to benefit from the United States' domestic oil boom has been through oil pipeline partnerships. Unfortunately, some of these partnerships cannot cover their payouts with operating cash flow and are relying upon debt or secondary stock issuances to fund expansions.

Plains All American Pipeline (NYSE: PAA  ) owns a whole host of pipeline networks and distribution terminals throughout the United States. The company's distribution has bounced between $0.55 and $0.60 per quarter for the first nine months of this year. Annualized, this is a yield of around 4.7%.

Plains All American Pipeline's operations within North America. Source: Plains All American Pipeline investor relations.

For the first six months of this year, Plains All American's cumulative distribution amounted to $559 million. This was easily covered by the company's operating cash flow of $1.34 billion. During the same period, Plains All American's capital expenditures only amounted to $785 million; this means that distributions and capital spending were easily covered by operating cash flow.

Plains is one of the few pipeline partnerships that is not leaning heavily on debt or equity issuance to fund expansion. During the last year, the partnership's total debt has only expanded by 6% and the number of shares in issue has grown by 3%.

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